Finding the Present Value Factor of an Annuity

Finding the present value factor of an annuity involves calculating
compounding interest over a given number of years based off a desired
end-goal. An annuity calculator can be used to find the present value
of a fixed annuity by entering an interest rate, the number of years
will be compounding, and the final total you'd like to achieve. Present
value calculations use the same formula as future value, but solve for
a different variable. Calculating the present value is useful in a
situation like retirement planning, where you have firm financial
objective in mind. To calculate the present or future value of your
annuity, use the free calculators below:

Calculating Compound Interest

The
formula for compound interest is as follows: FV = PV (1+i)^n where FV
stands for future value, PV stands for present value, i stands for
interest, and n stands for number of years. Let's run through a basic
calculation. What would a $30,000 initial investment yield after 5
years of compounding interest at 5%? That's simple enough, we just need
to solve for FV.

Here's
how we make sense of this formula: the first year our hypothetical
annuity investor starts off with $30,000. At 5% interest, at the end of
year one, this premium grows to $31,500. The second year our annuity
experiences the same 5% growth, but the initial investment has grown, so to
speak. At the end of year two the total balance becomes
$33,075. And so this trends continues, compounding the initial $30,000
over and over again for 5 years.

Present Value Annuity
Calculation

A
present value annuity calculator is used to determine how much one
would have to invest in an annuity to get a certain total in the end.
This is the reverse of a future value annuity calculation, which is used
to determine how much a certain initial investment will grow over time.
The formula for present value is: PV = FV / (1+i)^n. Let's run through
a present value calculation: How much would we need to invest today to
end up with $500,000 in 4 years, assuming a 9% rate of return? The math
goes like this:

In this case our hypothetical investor would have to place $354,00 in his annuity to end up with $500,000 in 4 years.

Factors of a Present Value Calculation

The mathematical formula for the discount factor is the
reciprocal of 1+ the rate of return. Factors
of present value calculation include the contract's term (in
years), the interest rate (in %), and the final amount (in $). These
three variables determine the initial contribution you'd need to make to
meet your final amount. As long as the rate of return stays constant
(as with a fixed annuity or cd-type annuity) the final amount will be
guaranteed.

Present Value Annuity Example

John is planning his
retirement and estimates that he'll need $300,000 by the time he
reaches the age of 65. John's currently 50 years old and has found a
fixed rate annuity that guarantees 8% interest for 15 years. How much should John invest today to meet his
retirement savings goal? For this we need to calculate the present
value of $300,000.

PV = 300,000 / (1+0.08)^15 = $94,572

This
future value calculation gives John a good ballpark of how much he
should be investing right now. A smart decision here would be to invest part of
the $100,000 in a fixed annuity, part in a money market account, and
part in an equity vehicle like a mutual fund or equity-indexed annuity.
This diversification would provide added security and give John a shot
at beating his $300,000 mark.

Retirement Planning with Present Value

Calculations for the present value of an annuity are used by financial professionals for retirement planning. First
it's determined how much one would need upon retirement to live
comfortably, then the initial investments one would need to make to
meet that goal are calculated. Identifying your financial objectives before investing is important, especially for annuities, because you don't want to run out of savings half-way through retirement.

Disclaimer: This is not investment advice. All information on this site is intended for educational purposes only. We are not liable for any potential damages that may be incurred from this information. Always consult a licensed financial professional before investing.